Why The Mega Millions Jackpot Is Nothing But Another Tax On America's Poor

Now that the Mega Millions Jackpot has just hit a record $640 million, people, mostly those in the lower and middle classes, are coming out in droves and buying lottery tickets with hopes of striking it rich. After all, with $640 million one can even afford a few shares of Apple stock. Naturally, we wish the lucky winner all the (non-diluted) best. There is, however, a small problem here when one steps back from the Sino Forest trees. As ConvergEx' Nicholas Colas explains, "Lotteries essentially target and encourage lower-income individuals into a cycle that directly prevents them from improving their financial status and leverages their desire to escape poverty. Yes, that’s a bit harsh, and yes, people have the right to make their own decisions. Even bad ones… Also, many people tend to significantly overestimate the odds of winning because we tend to assess the likelihood of an event occurring based on how frequently we hear about it happening. The technical name for this is the Availability Heuristic, which means the more we hear about big winners in the press, the less uncommon a big payday begins to seem." Call it that, or call it what one wishes, the end result is that the lottery is nothing but society's perfectly efficient way of, to use a term from the vernacular, keeping the poor man down while dangling hopes and dreams of escaping into the world of the loathsome and oh so very detested "1% ers". Alas, the probability of the latter happening to "you" is virtually non-existant.

Full explanation from Nick Colas on how and why Americans are lining up in lines around the block to... pay more taxes.

What Seems To Be Is Always Better than Nothing

Summary: American adults spent an average of $251 on lottery tickets last year. With a return of 53 cents on the dollar, this means the average person threw away $118 on unsuccessful lotto tickets – not a great investment. So why are we spending so much? Well, lotteries are a fun, cheap opportunity to daydream about the possibility of becoming an overnight millionaire, but on the flip side people tend to overestimate the odds of winning. Lower-income demographics spend a much greater portion of their annual earnings on lottery tickets than do wealthier ones. Since lotteries are state-run, that effectively means that the less affluent pay more in taxes (albeit by choice) than broadly appreciated. And even winning the lottery doesn’t guarantee financial success. More than 5% of lottery winners declare bankruptcy within 5 years of taking home the jackpot. Despite their drawbacks, though, lotteries are no doubt here for the long haul – in states that have lotteries, an average of 11% of their total revenues come from lottery ticket sales, and the number is even as high as 36% in 2 states (West Virginia and Michigan).

Note from Nick: Daydreams may be the best example of a product in an inflationary spiral; the price of a Powerball lottery ticket went from $1 to $2 on January 1st. That news got me thinking about the price elasticity of fantasies. After all, the state lottery commissions involved in this venture must believe that a 100% price bump will not deter enough customers to lower their overall take. That’s a big gamble (pun intended) to take on what is an increasingly important revenue input for many state budgets. Beth takes up the story from here…

Consider the following credit-card-advertisement style sequence of statistics:

Lottery ticket sales in the US in 2010: $59 billion

Average spending per person: $191

Average spending per adult: $251

Chance at hitting the jackpot: (Apparently) priceless.

I have never bought a lottery ticket and honestly don’t even know how. And as far as I’m aware, I don’t know anyone who spends north of 200 bucks a year playing the lotto. The only lottery my friends play is the NYC marathon lottery, where they’re gambling for maybe a 1 in 13 chance to fork over $255 for the privilege of slugging out 26 miles through the city’s streets. Not quite hitting the jackpot in most people’s minds.

But someone, somewhere is buying all those tickets. In Massachusetts, where the lottery is more popular than in any other state, people spend an average of $634 a year on Mega Millions, Powerball and the like. Delaware comes in at number 2 with $504 spent per person, while Rhode Island ($469), West Virginia ($388) and New York ($357) round out the top 5. North Dakota brings up the rear with per capita lottery spending of $34. You can see the full list in the table following the text.

It’s difficult to pinpoint exactly who is investing so much money in a product that provides poor returns, but numerous studies show that lower-income people spend a much greater proportion of their earnings on lotteries than do wealthier people. One figure suggests that households making less than $13,000 a year spend a full 9 percent of their income on lotteries. This of course makes no sense – poor people should be the least willing to waste their hard-earned cash on games with such terrible odds of winning. (http://www.dailyfinance.com/2010/05/31/poor-people-spend-9-of-income-on-...).

Why bother? Well, one answer is obvious enough and applies to just about everyone who plays. For a buck (now $2 for Powerball) we have a cheap opportunity to daydream what could happen if we suddenly won millions of dollars. But lotteries return 53 cents to the dollar. So why are poor people irrationally buying tickets when the probability of winning is so slim? One study by a team of Carnegie Mellon University behavioral economists (Haisley, Mostafa and Loewenstein) suggests it isn’t being poor but rather feeling poor that compels people to purchase lotto tickets.

By influencing participants’ perceptions of their relative wealth, the researchers found that people who felt poor bought almost two times as many lottery tickets as those who were made to feel more affluent. Here’s how they did it:

Participants were asked to complete a survey that included an item on annual income. One group was asked to provide its income on a scale that began at “less than $100,000” and went up from there in increments of $100,000. It was designed so that most respondents would be in the lowest category and therefore feel poor.

The other group, made to feel subjectively wealthier, was asked to report income on a scale that began with “less than $10,000” and increased in $10,000 increments. Therefore most participants were in a middle or upper tier.

All participants were paid $5 for participating in the survey and given the chance to buy up to 5 $1 scratch-off lottery tickets. The group who felt wealthier bought 0.67 tickets on average, compared with 1.27 tickets for the group who felt poor.

Lotteries essentially target and encourage lower-income individuals into a cycle that directly prevents them from improving their financial status and leverages their desire to escape poverty. Yes, that’s a bit harsh, and yes, people have the right to make their own decisions. Even bad ones… Also, many people tend to significantly overestimate the odds of winning because we tend to assess the likelihood of an event occurring based on how frequently we hear about it happening. The technical name for this is the Availability Heuristic, which means the more we hear about big winners in the press, the less uncommon a big payday begins to seem.

Not that hitting the jackpot is guaranteed to substantially improve the winner’s life. Economists at the University of Kentucky, University of Pittsburgh and Vanderbilt University collected data from 35,000 lottery winners of up to $150,000 in Florida’s Fantasy 5 lottery from 1993 to 2002. Their findings are as follows:

More than 1,900 winners declared bankruptcy within 5 years, implying that 1% of Florida lottery players (both winners and losers) go bankrupt in any given year, which is about twice the rate for the broader population.

“Big” lottery winners, those awarded between $50,000 and $150,000 were half as likely as smaller winners to go bankrupt within 2 years of their win, however equally likely to go bankrupt 3 to 5 years after.

5.5% of lottery winners declared bankruptcy within 5 years of bringing home the jackpot.

The average award for the big winners was $65,000 – more than enough to pay off the $49,000 in unsecured debt of the most financially distressed winners.

Lottery players tend to have below-average incomes, so they are probably less accustomed to budgeting when they receive a windfall. There’s also a psychological term called Mental Accounting that explains how people might treat their winnings less cautiously than money they’ve worked for. Money has come into their possession through luck, which similar to bonus payments, often induces an urge to purchase unnecessary items.

But whether you think state lotteries are awful or great, there’s another word for them: essential. In both West Virginia and Michigan, for example, lottery sales accounted for 36% of total state revenues in fiscal year 2010, and on average state with lotteries take in 11% of total revenues in the form of lotto ticket sales. We’ve included the full list in a table following the text. There are still 7 states that don’t have their own lottery systems, so the national average would be lower.

A couple of closing thoughts on what this all means:

Don’t make investment decisions when you are feeling poor. The study we cited earlier clearly shows that you are likely to buy more “lottery tickets” (think of that as a metaphor for any long shot investment) when you feel less affluent than those around you.

Lower income individuals likely pay more in “Taxes” than most economic commentators realize. Assuming that the 80/20 rule applies to lottery participation, the bulk of that $59 billion in annual receipts likely comes from 20-25 million less affluent households. That would be about $47 billion from this demographic, or roughly $2,400 per household. Yes, I get the notion that this money is handed over in the hope of a payoff. An ill-advised and mathematically unlikely hope, as it turns out. But does that mean it doesn’t count as a societal contribution?

Maybe the U.S. needs a national lottery. Yes, these games don’t necessarily encourage the best financial planning among the less affluent. But there is no denying that playing the lottery is entirely voluntary. There are probably some anti-gaming factions in government who wouldn’t like this approach, to be sure. But there’s also no doubt that the Federal budget could use the money. And, hey, you never know…

In college I had a math professor that claimed he could prove your chances of winning the lottery were exactly zero, though I missed how he came to that conclusion, yet for the odds being exactly zero there sure a lot of people who have won the prizes.

And then again Tyler may be on to something, I could take that $20 I paid for a chance to dream about financial security and invest it in PIMCO's new fund instead, ye HAW! Let the good times roll. Oh wait, financial advisors require a minimum of $1,000 mostly to open an account with them.

Gasoline is up $1.30 here in eight weeks, food up 25% in a year, if I do not play a few bucks on the lottery I will not even be able to dream about better times, calling it storing mental fat for the long winter we are entering in western civilization.

have to agree - anyone who is "horrified" about people voluntarily parting with a dollar or two, then maybe indulging in a couple minutes of fantasy as to what they might do with a huge lump sum of monies is a snob, IMO.

I have never bought a lottery ticket and honestly don’t even know how.

how very precious - translate: I'm way to clever to do what the lesser people do. . . give me a break - how much do people pay for sexual kicks 'n' favours? don't see anyone wagging a finger at that indulgence. . . or a meal out in the upper range prices, or booze, ciggies, I could go on.

a lottery ticket is a completely harmless daydream, and anyone who takes it seriously - like "investing" in the "stock markets" ^^ - is being subject to a stupid tax more than a "poor tax" - trading fiat paper for a Powerball slip of the same - priceless.

disclosure: I indulge when the jackpots go silly numbers, one ticket only, based on a belief that if it's gonna happen, one ticket will do it - if not (most likely), then it's just a buck, harmless.

U.S. stocks' stellar performance so far in 2012 is remarkable in part for the anemic trading volumes that have accompanied Wall Street’s rise, and those on the sidelines, as with the lottery, stand no chance.

my friend's aunt makes $72/hr on the internet. She has been without work for six months but last month her payment was $19183 just working on the internet for a few hours. Here's the site to read more ..... http://lazycash9.com

On Thurs, ZHers here were explaining that it was worth it to "systemically attack" the lotto by buying tix when the payout value exceeded the number of combinations. Here is the tally:

Americans spent nearly $1.5 billion for a chance to hit the jackpot, which amounts to a $462 million lump sum and around $347 million after federal tax withholding. With the jackpot odds at 1 in 176 million, it would cost $176 million to buy up every combination. Under that scenario, the strategy would win $171 million less if your state also withholds taxes.

And so, if you do the math, the after-FED-tax value of $347M is reduced by state taxes of $171M to net...wait for it...$176 million. So the tax code on the lotto forces it to be no better than a push.

But we'll all take the $176M, so it was worth the few fiats, right? So let's go back to the top line: $1.5 billion "spent." So the net proceeds to the "winner" taps out at $176 million on a top line of $1.5 billion. And so I get back to my core question: what would the wealth effect be if there were no lotteries?

Yeah, well, your professor is an idiot. Anyone even vaguely familiar with the concept of "Expected Value" knows that, with a jackpot of $640 million, Mega Millions is a screaming buy. Here's a simple example; a friend says let's play a game - we roll a die. If it comes up 6, you get $5, otherwise i get $1, and we have to play 24 times. This is a "fair" game - your expectation is exactly zero. On average, you'll win 4 times ($20), and lose 20 (-$20). If he changes it to $6 when you win, but still only $1 when you lose, you should play every chance you get, as your net expectation is now $0.13 per roll (win 24/lose 20).

But there are also secondary prizes. Chance of second prize ~ 1/4 million, value $250,000, Expectation = $0.06

The other prizes for matching 3,4 numbers are smaller, but the total expectation per $1 ticket is about $2.25 when the jackpot is this high.

In other words, when the jackpot is low, playing more than one ticket (for the entertainment/fantasy value) is not a good idea. Far better to save your cash for when the jackpot exceeds $175 million after tax, and then plunk down $20. You still probably won't win, but at least the math is on your side.

buying them of my own accord before they are mandated in the Obamalottery bill which states, since everyone will need money at some point in their lives, they will be forced to purchase a shot at winning said moneys

If I were a socialist I`d encourage lotteries. They run full square counter to entrepreneurship and thus discourage risk taking in a sensible way, gambling and criminal conduct intertwined , the victim would invest into a so called public company without regret or remorse and would since be ruled by a group of chairman or politburo .

if you're stupid enough to support a moronic pernicious system, then go ahead and by some tickets. and en route buy a fucking happy meal. the only thing resembling a vote in these dire times is a vote with your dwindling fiat dollar.

oh and you still get TAXED on your winnings motherfucking-a sheer insanity is what we tacitly agree to!

You are about 50 times more likely to get struck by lightning than winning the lottery, based on the 90 people a year getting struck by lightning.

Based on other U.S. averages, you're about 8,000 times more likely to be murdered than to win the lottery, and about 20,000 times more likely to die in a car crash than hit the lucky numbers, Catalano said.

You're about 100 times more likely to die of a flesh-eating bacteria than you are to win the lottery.

The only trick there is that you can't increase your odds of winning. But if you do win, you can increase the odds that you're the only one who wins. In other words, you don't have to share the jackpot. And the way to do that is to pick uncommon numbers. Many people tend to pick birthdays, favorite numbers, and these tend to be small. The numbers that you can pick for Mega Millions go as high as 56. But, of course, dates only go as high as 31. People tend to pick odd numbers more than even numbers. So, even numbers larger than 31 are less common. But, again, whatever strategy you pick for choosing your numbers doesn't increase your odds of winning.

But if you do win, you can increase the odds that you're the only one who wins.

Just run the same numbers multiple times on your ticket, that way you'll have multiple "shares" and get more than anyone else you have to share with.

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Seriously, though: "gambling" in general could be considered a tax on the stupid, except that for many people, it's entertainment, something like video games or movies or whatever. For certain I never see high-earning guys in suits lined up in the bodega buying dozens of scratch-off tickets at a time, but they may well be able to fly to Vegas and engage in basically the same activity. What would I care?

What is certainly true, and in my view problematic, is that if you structure society in such a way that job devotion and experience and detailed knowledge are not REWARDED, you end up with a lot of people hating their jobs and doing shitty work. Sure, prices may be lower, but quality may suffer.

There's nothing healthy about people's only real hope for a better future to be tied up in winning lotteries, or winning big lawsuit payouts, or whatever. Everything about our corruption is largely an outgrowth of a concerted effort to drive down wages over the past several decades.

Next time go with the buzzword inclusion as in doubling the workforce with the inclusion of women was not supposed to effect wages if one was a ardent reader of the zerobrains posts on the bathroom stalls in the early 70's. Lump of labor fallacy was written with sharpie above call this number for a BJ.

What is certainly true, and in my view problematic, is that if you structure society in a way that there is boundless opportunity, but continually face the earth is flat crowd you will never win.